Australia: The proposed one-year bankruptcy

Is faster better?

On 19 October 2017, the Bankruptcy Amendment (Enterprise Incentives) Bill was introduced to parliament proposing reduction of the term of bankruptcy to one year.

The concept of a one-year bankruptcy is not a new one. The Bankruptcy Act 1966 previously allowed discharge after 12 months at the bankruptcy trustee's discretion, called "early discharge".

According to the explanatory memorandum to the Bankruptcy Legislation Amendment Bill 2002, early discharge was scrapped because:

The reduced period of bankruptcy is seen to discourage debtors from trying to enter formal or informal arrangements with their creditors to settle debts, and provides little opportunity for debtors to become better financial managers.

The authors of the 2017 Bill argue that reducing the automatic discharge to one year is predicted to incentivise entrepreneurs who previously refrained from launching business ventures due to the perceived risk resulting from bankruptcy laws.

We must therefore ask: Is the 2002 justification for scrapping early discharge still relevant today?

My answer is yes.

The 2002 explanatory memorandum identified that the early discharge policy failed to promote positive financial outcomes for 'consumer debtors'. These are debtors with low asset backing who overextend primarily on consumer credit facilities such as credit cards, store cards and personal loans. In 2016/17, consumer debtors represent approximately 85% of all bankruptcies, with 16,320 recorded in that period.

In 2004, debt agreements were introduced into the Bankruptcy Act. Data from the Australian Financial Security Authority (AFSA) shows that debt agreements are increasing in popularity year-on-year. They also provide better commercial outcomes to creditors of consumer debtors than bankruptcy. In 2016/17, there were 13,597 debt agreements.

We can't simply add these statistics together, because some bankruptcies follow failed debt agreements. However, we can conclude that consumer debtors comprise the overwhelming majority of personal insolvencies.

Assuming the 2002 justification is relevant today, and given the above statistics, I believe that it is, then the parliament should be debating which policy represents the greater good:

  • A one-year bankruptcy—which encourages entrepreneurs and stimulates economic growth.
  • A three-year bankruptcy—which is less likely to be abused by debtors as a mechanism to avoid their debts.

What would a one-year bankruptcy mean for debtors?

Under the proposed bill:

  • A debtor would be automatically discharged from bankruptcy after one year.
  • The amendment would apply to all existing bankruptcies, meaning those bankrupt estates already in excess of one year would be discharged.
  • Other periods associated with bankruptcy would also be reduced to one year. These include disclosing bankruptcy status when applying for credit, seeking permission for overseas travel, attaining certain licences, and entry into certain professions and membership bodies.
  • Income contributions to a bankrupt estate would be extended for a minimum of two years post discharge; meaning that the period for income contributions would remain at three years.
  • Objection to discharge laws would remain; allowing the bankruptcy to be extended to five to eight years.
  • Debtors will also still be required to assist in the management of their bankruptcy even after discharge.

What would a one-year bankruptcy mean for creditors?

The authors of the 2017 Bill argue that reducing the bankruptcy period to one year would have no significant impact on creditors. Their justification is that bankruptcy trustees' statutory powers to investigate, acquire, and distribute financial assets remains unchanged, as does a creditor's right to submit a claim and receive dividends from the bankrupt estate.

However, based on the 2002 justification for scrapping early discharge, there must be a risk that outcomes for creditors could be affected in consumer bankruptcies.

What would a one-year bankruptcy mean for advisors?

If the Bill is passed, negative consequences for debtors will reduce in duration, though not severity. Advisors will need to adjust their advice to clients regarding:

  • The consequences of failure of risk-taking enterprises.
  • Options available to clients facing personal insolvency, including choosing between bankruptcy and debt agreements (the latter is usually more commercially onerous and much longer in duration than the former).
  • Personal risk for directors of insolvent companies who also benefit from recent amendments to insolvent trading laws.

What would a one-year bankruptcy mean for business?

Reducing the stigma of bankruptcy and the associated credit availability implications, removes some barriers for entrepreneurs. As such, the authors of the Bill predict that the proposed reform would increase new enterprises and innovation and improve commercial growth.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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